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Answer: The forward price is a biased estimate of the expected future spot price because the riskfree rate is positive and the commodity exhibits idiosyncratic risk
**Correct answer: A** For gold, the forward price is generally **not guaranteed** to equal the expected future spot price. The reason is that commodity prices may include a **risk premium**, and gold can exhibit price risk that matters to investors. So the forward price can be a **biased estimate** of the expected future spot price. Why the other options are wrong: - **B**: The statement is vague and the reference to "$1,800" does not match the given forward price. - **C**: Correlation with the market does not make the forward price unbiased; it can create a risk premium. - **D**: Arbitrage eliminates pure pricing inconsistencies, but it does **not** remove all risk premia from expected spot prices.
Author: Manit Arora
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Question 186.4: The twelve month forward price of gold, F(0,1), is $1,880 per ounce. According to the assigned authors (Hull, McDonald and Geman), which is the best statement about the relationship between the forward price and the expected future spot price of gold in one year?
A
The forward price is a biased estimate of the expected future spot price because the riskfree rate is positive and the commodity exhibits idiosyncratic risk
B
The forward price is a biased estimate of the expected future spot price because investors are risk averse; i.e., expected future spot price, E(1), does not equal $1,800
C
The forward price is an unbiased estimate of the expected future spot price because returns of the commodity are correlated with the market
D
The forward price is an unbiased estimate of the expected future spot price because arbitrage reduces the risk premium to zero
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